Real estate always in style for the rich

Whether it’s buying a waterfront home, a publicly traded real estate investment trust, an apartment complex or investing in a trophy high-rise building, wealthy Americans need and want real estate exposure.

The ability of real property to provide income and diversification to a portfolio filled with stocks and bonds is a major part of its appeal.

There’s always a place for real estate in the asset mix of the rich, no matter what inning of the economic cycle we’re in, according to financial advisers. Still, 10 years into the longest expansion ever — and with prices for most properties elevated and fears of a U.S. recession rising — advisers say caution is warranted.

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“Now’s not the time to try to get rich quick,” said Mark Bell, head of family office services and private capital at Balentine. “Whether or not the top is in, we don’t know. But we can say we’re late stage. So why reach?”

Recession fears aside, investing in real estate still offers three benefits for the wealthy. It’s an inflation-fighting asset that preserves purchasing power. It’s a vehicle to transfer wealth from generation to generation. And it has a history of preserving wealth.

While most advisers recommend that real estate make up 5% to 15% of a portfolio, the size of the allocation depends on a client’s circumstances.

Clients with assets in the tens of millions of dollars can better afford to have sizable stakes in real estate, which tends to tie money up longer, Mr. Bell said. But it makes less sense for a client with an $8 million account who owns a $4 million home to make an even bigger land-based bet.

Similarly, if a client is in line to inherit 10,000 acres of farmland, upping his exposure with an agricultural REIT is overkill.

Clients often come to advisers with real estate stakes of various sizes, said Peter Bermont, managing director of Bermont Advisory Group at Raymond James. “They say, ‘I have this wonderful apartment building in Memphis. Should I buy another one? What do you think?’ That’s where I come in as their adviser.”

The three most common real estate investments for wealthy clients searching diversification are REITS, direct ownership and private equity. And thanks to the tax changes approved in 2017, there’s a new option that some advisers advocate.

1. REITs

An easy way to gain exposure is to buy REITs through public markets with low-cost exchange traded funds (ETFs) or index mutual funds. REITs provide broad diversification, tax-efficiency, high-income potential and liquidity (which means investors can buy and sell them easily and quickly).

Vanguard Real Estate ETF (VNQ), for example, tracks a variety of REITs, including “specialty” residential, retail, office, and hotels and resorts. Its 3.56% dividend yield as of July 31 was double the 1.50% yield on the 10-year Treasury.

Sector-specific REITs offer a way to invest in niches. Christian Thwaites, chief strategist at Brouwer & Janachowski, likes residential REITS. It’s a play “on the renting rather than owning” trend, he said.

One caveat, though, is the ease with which investors can enter and exit a REIT position. As a result, REITs are increasingly moving in lockstep with stocks, making them vulnerable to sharp market sell-offs, Mr. Bell said.

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REITS make most sense for clients with fewer investible assets.

2. Direct ownership​

Buying a suburban office building or apartment complex directly on your own or with a small group of investors is more involved and costly. Also, it requires expertise to identify worthy deals and to manage the property profitably.

“If they have the interest, the experience, the team and are entrepreneurial, then they can do it on an individual basis,” said Joseph Janiczek, CEO and founder at Janiczek Wealth Management.

If they don’t have the bandwidth, it’s better to invest with big, specialized real estate funds.

3. Private equity​

Going with a real estate management company that does the investing allows the client to piggyback on its expertise. These managers employ a core, opportunistic or value-added strategy.

A “core” strategy that pension funds favor because it’s the least risky involves managers buying trophy hotels and upscale office buildings in both major and gateway cities. If tenants move in, stay and rents go up, the investment is akin to bonds, “which are essentially providing the role of income and inflation-fighter,” Mr. Bell said.

The “opportunistic” strategy, which takes a riskier approach, tries to take advantage of local market knowledge by buying distressed real estate assets and then renovating or building new, and charging higher prices. “Value-added” managers fix up a “B-property and make it an A-asset,” by putting new landscape in, painting and sprucing up units, Mr. Bell said.

4. Qualified Opportunity Zones

Additionally, the 2017 tax law changes made possible tax-friendly investments in Qualified Opportunity Zones. Aimed at spurring development in distressed communities, investors in these areas may defer taxes on previously earned capital gains. And for new opportunity zone investments held at least 10 years, investors will pay zero taxes on gains.

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The tax breaks are the reason Mr. Bell recommends this option to clients, but only if they’re willing to lock up their money for 10 years and invest in “no less than a dozen deals” to ensure diversification across different types of real estate as well as geography.